You are viewing this page, so you probably want to feel financially secure, both now and in the future, and likely have wealth aspirations beyond that, such as financial independence or an extravagant retirement. What follows is my advice for building your wealth to achieve your goals. I laid it out in multiple stages, so hopefully anybody at any point in their wealth building journey can get something out of it.
This stage is the set of steps to do when you are just starting to focus on building your savings. These steps are very easy to complete and help you build saving/investing confidence.
Open an online interest-bearing checking account, preferably with ATM fee reimbursement. I use Ally Bank and am happy with them. Direct deposit your pay to it instead of your regular local bank account. Use free mobile check deposit to deposit checks. Use the account to pay your bills and transfer money to other accounts. It will not earn you much, but at least you will get something for the money you need to keep in it.
Try to keep the balance only as high as you need it to feel comfortable you can pay your bills. You will want to move the excess to better savings options. You can keep your local bank checking account if you want local deposit and withdrawal abilities but try to keep it at the minimum allowed balance that avoids service fees.
Open one or more rewards credit cards and use them to pay for everything you can instead of cash or checks or bank account debit cards. Find cards that give you the best benefits for your spending habits. Some examples:
Do not open cards with annual fees. Pay off the entire balance every month. Periodically redeem your cash back. Letting the rewards sit there forever is just a no-interest savings fund. For the Citi card, redeem rewards to your bank account instead of using them to lower the balance so you can still get the "1% when you pay".
Most companies will only match your contributions up to a certain amount. If that is the case for you, make sure you are contributing at least enough to your work retirement plan to get the full company match. Think of it as a guaranteed return on your investment every year of at least that percent. If your company matches on all of your contributions, lucky you, contribute as much as you are comfortable with while you complete the rest of stage 1.
Stick with normal, pre-tax contributions for now, rather than Roth. Roth contributions are after tax, meaning you have less to invest. Less invested means less compound earnings potential. The benefit of Roth is that you pay no taxes on what you contributed or the earnings when you withdraw the money. Unfortunately, this benefit usually does not outweigh the reduced growth.
Normal, pre-tax contributions are a great thing while you are working hard and making lots of money that the government wants to tax. Your taxable income gets reduced by the amount of your contributions so you pay less income taxes. You can invest more with less impact on your paycheck and you get more compound earnings potential. When you withdraw the money, you pay income taxes on what you contributed and the earnings. You want the extra compound earnings potential from the pre-tax money, and chances are you will be in a lower tax bracket when you retire because you need less money to live on than you earn now.
Look at your retirement plan and find the mutual fund choices that have the lowest administrative costs (look for "expense ratio"). Usually, the lowest cost funds are passively-managed "index" funds (look for that word in the fund name). These funds just track the stock/bond/etc. market performance to get good returns and charge minimal or no administrative fees. Try to split your money 20% in a bond index, 60% in a US full market stock index, 20% in an international full market stock index. Try to use as few funds as possible to keep things simple. If you can’t get bonds or international, put that extra percent into the US index. If you can’t get a US full market index but you have other partial market index funds available, go with all “large cap”, or optionally put a little of the US stock allocation in a “mid and small cap” fund. For example, 20% bonds, 20% international stock, 50% US large cap, 10% US mid/small cap.
Remember to periodically check back on your account. Set yourself a reminder once per month or every other. If the percentages start to skew away from this ratio, use the rebalance function of your account provider to shift money from the categories that have grown faster to the ones that have grown slower or lost value. The rebalance is effectively selling high and buying low at the same time (or at least selling low and buying lower). It keeps your account earnings more stable as the individual markets fluctuate and actually earns you more money in the end.
If this sounds like too much work and you would rather pay extra of your money to have someone else manage it for you, consider a “balanced” or “Target Retirement” fund. But make sure it has a low expense ratio and high % stock.
Choose a high-deductible health insurance plan with HSA (Health Savings Account) if you have one available to you, and if it makes sense for your health situation. The important thing to remember is that the HSA is the ultimate retirement plan. Your contributions to it are pre-tax. Your money grows tax free. Your withdrawals from it for medical expenses are tax free. Your withdrawals from it during retirement for non-medical expenses are just like a pre-tax 401k / 403b.
Contribute the maximum amount for the year to it. Make the contributions pre-tax from your pay. Divide the max by number of pay periods and withhold that amount from each check so you barely notice. If your employer will contribute to your HSA for you, subtract their contribution from the limit and contribute the rest yourself. In the HSA, invest the money in index funds just like your 401k / 403b above and also remember to rebalance it periodically if possible.
Do not use your HSA to pay your medical bills now. Just let the money grow like a normal retirement plan. Pay with your reward credit cards and save the medical receipts. You can use those receipts at any time in the future to withdraw the money from your plan tax free to retroactively pay yourself back. You report the withdrawal on your income tax return that year and have the receipts in case you get audited for some reason. If you wait until retirement to withdraw the money, you will have a lot of tax free contributions plus growth and you will have banked a bunch of tax free withdrawals. If you have an emergency and need the money sooner, you can at least still withdraw the prior medical expenses tax free to help with your emergency, but do this as a last resort so it can just keep growing.
Save your physical receipts but also make an electronic copy of them. Many HSA providers allow you to upload your receipts to their site but HSA providers can change over time. I suggest you just email the receipts to a personal gmail account or something and collect them there forever in a separate folder.
Calculate the amount of money that you will feel comfortable living off of for 6-12 months if needed, or to pay for large emergency situations that come up. Start saving toward that amount. As you go, open one or more high-interest savings accounts from reputable banks that will give you the best rates of return. You can easily get at this money within a few business days if you need it. Otherwise, it earns you free money (or at least tries to keep up with inflation) that you can periodically withdraw and use for other more advanced investing options. Search the internet to find the best available rates, or just check out my recommendations here.
Once you have completed the previous stage, you will have a strong emergency savings fund and basis for really starting to ramp up your investments for retirement. These steps are more complicated but they are worth the effort if you want a secure, or even early, retirement.
The IRS limits the amount you can contribute to these plans each year. Take full advantage of it. Allocate as much of your earnings as possible to max out this limit. Keep it simple and stick with all pre-tax contributions still, not Roth. You absolutely want these contributions deducted pre-tax to lower your Federal and State taxes now while you are making lots of money.
NOTE: Your employer match most likely only happens if you also contribute for the pay period. This means, if you cap out your contributions before the end of the year, you will miss out on match money for later pay periods. Avoid that! Divide the limit by the number of pay periods in the year and contribute that amount each pay period.
Even if you have an employer-provided retirement plan, you are still allowed to contribute to an IRA (Individual Retirement Account). There are two types of IRA, Roth and traditional, just like with a 401k / 403b.
There is an annual limit for IRAs just like other retirement accounts. You are always allowed to contribute to a traditional IRA, regardless of income. If you contribute to a traditional IRA, the IRS may allow you to deduct those contributions on your tax return based on your income level. This means a traditional IRA may contain pre-tax and after-tax contributions (pre-tax is what you deducted). When you withdraw the money in the retirement, you pay no taxes on your after-tax contributions, but you still pay income taxes on all the earnings. If you make after-tax contributions, make sure to keep track of the amounts so you can withdraw them tax-free later. The IRS will not track this for you.
With all that said, the IRA is where you want to contribute Roth. This is because taxes have already been paid on your income so your contributions might as well be Roth so you do not have to pay taxes on the future earnings they generate. You should front-load the IRA. This just means you buy it all at the beginning of the year and then refill your savings with your pay. Allocate and balance your IRA just like the other retirement accounts.
Unfortunately, the IRS does not allow you to contribute directly to Roth if your income is too high. Income level is difficult to predict due to raises, bonuses, overtime, etc. If you suspect you might have too much income to contribute directly to Roth, I suggest the following approach instead of contributing to Roth directly and having to correct it later. Note that this approach may be disallowed starting in 2022 depending on the final passage of the Build Back Better Act.
If you already have a traditional IRA (or multiple) with pre-tax contributions, you want to move this money if possible. The IRS considers all of your traditional IRA accounts as one large account. Having any traditional IRAs would cause tax problems that you want to avoid. Plus, managing traditional IRAs alongside a 401k / 403b is just extra work. Check if you can roll your IRA into your 401k / 403b account. Also, compare your fund costs in your IRA to your 401k / 403b. If your 401k / 403b has similar or better fund costs and you can roll your pre-tax IRA money into it, do that. Only roll the pre-tax portion of the IRA into your 401k / 403b.
Open a traditional IRA and Roth IRA with a brokerage that offers low-cost or no-cost index funds. Fidelity currently has a few no-cost index funds and many other low-cost funds and they offer a lot of investing options and tools and fund choices and there is a pretty good chance they already manage your work retirement plan. Vanguard is another good option.
Put the maximum amount into the traditional IRA. Now, if you were able to eliminate your pre-tax IRA balance or you didn’t have one, you can then use a "Roth conversion" to convert the traditional IRA to the Roth IRA. There is no income limit on this conversion but the IRS must see that it is an independent step. Also, you have to pay taxes on any earnings that get converted in the year that you convert. I suggest doing the conversion very soon after making the traditional IRA contribution to limit the amount of earnings but still make it a clearly independent step to the IRS. Make sure to choose “no tax withholding” so the entire balance gets converted to Roth. You don’t want any of the funds being withheld and paid toward taxes for you.
You can still do this conversion process if you have pre-tax IRA balances, but the tax implications are more complicated and you should probably talk to a financial advisor before doing it. If your pre-tax IRA total balance is small enough and won’t affect your income taxes too much, you may end up wanting to just convert it all as another option for eliminating the old pre-tax IRA(s).
Open a free account at Personal Capital for centrally tracking your savings. Link this account to your various accounts and it will automatically collect and track your financial data and give you nice historical charts and investment diversification breakdowns. It will also let you run retirement plan studies to see how well you are doing based on various good/bad scenarios. You can use the account just to track investments, or include spending, savings and checking to get a complete picture of your finances.
The company offers paid investment consulting too that they will try to get you to use (offering a free consultation to start) but you can just ignore them or say you are not interested if they call.
Once you complete stage 2, you are a seasoned saver. Your retirement accounts are being well funded. You are maximizing the interest earnings on your emergency fund savings. You are monitoring your savings progress and considering your retirement options. You still have extra money that you want to save to bring that retirement date even closer. These steps give you some ideas of how to do that.
Didn’t we already cover this in step 7? Well, not really. In step 7, I told you to max out your contribution to the plan and in step 3 you maxed out your employer contributions. There is actually another limit to 401k / 403b plans. It is the overall annual contribution limit. This limit includes your individual contributions, your employer contributions and also any non-deductible after-tax contributions. That last one is the key here.
The individual contributions are limited by the IRS each year as we previously discussed. The employers typically limit their own contributions. Employers usually match your contributions up to a certain percentage of your pay or a fixed dollar amount. Some employers will also contribute profit sharing to your plan.
Assume you contribute $19000 and your employer match gives you $4000 over the year and they give you another $2000 in profit sharing. So far, you both have contributed a total of $25000 to your plan. The IRS says the maximum total contribution is $56000 (for example, check current year limits). That leaves $31000 that you can still contribute to your plan. However, you can only do this if your plan supports non-deductible after-tax contributions.
After-tax non-deductible contributions are just like after-tax contributions to a traditional IRA. The earnings on those contributions will be taxed as income (high tax rate) when you eventually withdraw them. This type of contribution is only desirable over normal taxable investing if you can combine it with the following Roth conversion process. Note that this approach may be disallowed starting in 2022 depending on the final passage of the Build Back Better Act.
Check with your company or your plan administrator to see if you are lucky enough to have this type of contribution and if your plan supports “conversions” or “in service distributions” of these contributions. If so, estimate the amount of extra money you can contribute to it. Make sure you leave enough space for the company match and likely profit sharing throughout the year. You do not want to put too much of your own money in and prevent your company from giving you free money. Then, tell your plan to withhold that extra amount from your pay. It will get invested alongside the rest of the money in your plan and you can manage it all in one place.
One or more times throughout the year, convert these after-tax contributions to Roth, either within the plan or by a distribution to your IRA. The earnings on the contributions that have accrued since you made the contributions will either stay in your pre-tax bucket or they will be converted as well and you will have to pay taxes on them in the year of the conversion. The contributions themselves would be moved to your Roth bucket, so you can withdraw all of the future earnings tax-free. This is an amazing way to get a ton of money into your Roth savings.
Set yourself a reminder to perform these conversions as often as possible throughout the year so that you move your money over to Roth as soon after contributing it as possible.
If your company plan does not support the conversions or in service distributions but does support the after-tax contributions, you have a fallback. If you plan to leave your current employer in the next 3-6 years, you can still make the contributions. When you leave your employer, roll your 401k / 403b to a normal IRA and Roth IRA. Send all of the after-tax non-deductible contributions to the Roth IRA, but send all of the earnings and other pre-tax money to the normal IRA. You still get to convert your contributions to Roth, but you have potentially left several years of Roth earnings in pre-tax bucket. Oh well. At least you get the Roth benefit moving forward, and the few years of pre-tax earnings really are not that bad. If you do not plan to leave your employer in that time, you are likely better off investing this money in a taxable account because earnings in that type of account will fall under capital gains, which are taxed lower than income.
You are already familiar with low-cost mutual fund investing from your various retirement accounts so this is the next logical step. If you went with Fidelity for your IRAs, you can just stick with them and open a normal taxable brokerage account too. With this account, you can buy or sell whenever you want, unlike with retirement fund investing. Just remember that this account is taxable, so any sales result in taxable events that you have to report to the IRS in your tax return and potentially pay taxes on if you had gains or write off as losses.
Also, these taxable brokerage accounts can have some investing fees. Look for the word “commission” when considering funds to invest in. You want the low-cost index funds, like with your retirement accounts, but you also want the ones that have commission-free trading (free purchase/sale). You do not want to have to pay money just to buy or sell these funds. Fidelity has many of these options. Other brokerages offer them as well if you don’t go with Fidelity.
Setup your checking account with a recurring transfer to your brokerage account for the excess money you want to invest. Then, set yourself a weekly reminder (ex. Monday) to buy mutual funds in this account with that money. Just like with your retirement accounts, allocate your money across the different classes of index funds. Always stick to the schedule regardless of the market conditions to avoid pitfalls associated with investing fear psychology.
Since you are buying funds each week, you can actively keep the account balanced. If your stock values rise faster, making your bond percentage fall, buy extra bond percentage that week to correct. You can build a simple spreadsheet to calculate your weekly purchase amounts for you. Don’t worry about selling any of the categories in this case to rebalance unless the percentages really start to get out of whack. As I mentioned before, the sales would be taxable events so you want to avoid them in this account in most cases.
If this sounds like too much work, there are some ways to simplify. You can typically setup automatic purchases on fixed dates each month, but then you cannot actively balance your funds or keep your purchases on the same weekday. Sacrificing consistent weekday purchases is probably fine but you need the balancing. If you want to pay more of your money to have somebody balance it for you, consider a single, low-cost “balanced” fund or create an account with Betterment. Fidelity and Vanguard provide some “Target Retirement” funds that have an expense ratio of ~0.15% per year ($1.50 per $1000). Betterment invests in low cost funds behind the scenes and will automatically keep your ratios balanced and provide tax optimization strategies. They will charge you 0.25% per year ($2.50 per $1000) on top of the expense ratios charged by the underlying funds they invest you in, but people have found that the tax optimization they provide may actually pay for that fee (while complicating your taxes due to the frequent purchases and sales).
After step 11, you should be somewhat familiar with using a normal taxable investment account but you have so far stuck with mutual funds. If you have even more money, you can start buying individual stocks and/or exchange traded funds (ETFs). You may have heard of a company or ETF that you think has great potential and you want in. This is how. Just be careful not to get suckered into stock gambling. Individual company stock investing is very risky and you should only buy it if you do your research and really want to own a piece of the company.
The main difference between mutual funds and these guys is that you often must buy and sell full shares of these and you can buy or sell them at varying prices throughout the day. With mutual funds, you can buy or sell based on a dollar amount and own partial shares and your transaction happens at the end of the trading day. ETFs are otherwise just like mutual funds. They have expense ratios and invest in many stocks for you. Pick your ETFs like you would pick a mutual fund.
More and more stock brokerages are moving to commission-free trades for stocks and ETFs. If you want to buy/sell stocks and ETFs, open a brokerage account that lets you buy and sell stocks and ETFs for free.
Once you have $100k of mutual fund, ETF and/or stock investments in IRA or taxable brokerage accounts under your control (not employer retirement plans), you can use that money to boost your credit card rewards.
Bank of America owns Merrill Edge. Merrill Edge is basically just a self-managed brokerage like many others out there. The special thing about it is that when you transfer $100k into Merrill Edge, you get a nice cash bonus and that amount of money invested qualifies you for Bank of America “Platinum Honors”, which boosts your BofA credit card rewards. You can then open several BofA Cash Rewards cards to earn 5.25% on gas, online shopping, dining, travel, drug stores and home improvement/furnishings, as well as 3.5% on groceries and wholesale. You can also open the BofA Premium Rewards card to get 2.625% on everything else, but it has an annual fee so only do it if you can take advantage of the other benefits of the card to offset that fee (otherwise, just stick with a normal 2% back card for everything else).
Bank of America is pretty strict about their new card approvals so you will have to space out your card applications as follows:
If you have so much money to invest that you get bored with mutual funds and stocks, you can start getting more creative.
You could consider Peer to Peer Lending Investing. Here, you make your money available along with other investors to private borrowers. As they pay back their loans, you make money on the interest. If they default, you may lose some money. Most of these platforms allow for various risk levels and pools of loans that you buy into, where lower risk means lower returns. Getting access to the available loans is becoming more and more difficult with large-scale investors flooding the systems.
You could invest in local start-ups and other such endeavors. This has much the same risk as buying an individual company’s stock, except it is probably the riskiest type of company stock to purchase because it has no track record. Maybe invest in yourself and start your own business with your million-dollar idea…
You could buy investment properties to rent out, or to fix up and flip if you like side labor projects. Just make sure you have a good plan in place for finding and managing your tenants if you are renting, or for completing your fix and flip in as short of a time as possible while turning a profit competitive with market investing.
The sky is the limit. Let me know if you have other ideas.
Finally, start making your retirement plans. Gather up all of your balances from your various accounts and the various types of pre-tax, Roth and after-tax money in them. Project those numbers forward based on conservative earnings estimates and future contributions. Estimate how much money you will need each year to live comfortably. Play with different scenarios of when to quit your job, including prior to standard retirement age if that interests you, and see what your savings will support. Consider your future tax rates and if you can use Roth conversions to fill out lower tax rates and avoid future Required Minimum Distributions that will push you into high tax rates during standard retirement. Leave inflation out of your calculations and think in terms of today’s money to simplify things. I can help you get started with these calculations if you are interested in doing this yourself. Otherwise, you can find a financial advisor that you trust to do the calculations for you and that can walk you through the options so you understand them. I highly caution against handing your savings over to somebody to manage this for you unless you really trust them with your future livelihood.